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Performance Bonds: It's Not A Done Deal Until It's A Done Deal

03 May 2022

 

If you've ever wondered what a performance bond is, you're not alone. A lot of people have never heard the term before, and even those who have often don't know what it means. Performance bonds are a simple way to guarantee that a company will follow through on its promises to clients, but they can be confusing if you haven't heard of them before.

The performance bond is a financial guarantee—and trust us, it's there for a good reason. It lets the client know up-front that the work will get done as promised and agreed upon in the contract and that their investment won't be lost or wasted.

One of the most common uses for performance bonds is in construction projects. For example, if a developer hires a contractor to build a commercial development, they will likely require that contractor to put up a performance bond as security that they will complete the job.

This type of arrangement protects both parties: if the contractor were to stop mid-way through construction and disappear with all of the materials and money he's been given, then his performance bond would be forfeit, allowing the developer to get his materials and money back.

The name "performance bond" may seem intimidating, but it's just another way to ensure that important projects are completed on time and within budget. As long as the contractor has a good track record, they should be able to obtain a performance bond without too much trouble.

How To Get a Performance Bond

Performance bonds are often required by government agencies or large corporations, who may want to ensure they receive their money's worth before paying out any funds. That way, if things go wrong and they need to pay someone else to finish, they are still covered by Surety provider rather than having to pay out of pocket for all expenses incurred by failure on the part of their contractor.

Each surety bond company will have its own procedures for issuing performance bonds. If you're a business that needs to obtain a performance bond, here are two standard requirements:

a) 12 months trading history

b) Positive finacial reporting

If you have worked on other projects before and you are able to provide references to back up your ability to deliver on time and within budget, then the chances are that you will be more likely to get approved for a performance bond, this is why the Work In Progress (WIP) form is critical to the application.

Good credit is essential for smaller contractors. However, suppose your credit score is not that great. In that case, surety companies are more than likely to deny coverage entirely or apply increased security requirements rather than offer higher premiums to mitigate the risks.

What Do Performance Bonds Cover?

The bond covers three different parties: the obligee, principal, and Surety.

The obligee is the recipient of the guarantee—the party who requires this bond in order to award contracts or release funds. This is usually a government or corporate entity seeking a guarantee that contractors will complete a specific project according to predetermined specifications.

The principal is the individual or company seeking a contract with an obligee—the person who must obtain this bond in order to meet contractual obligations and receive payment for their work.

The bond is issued by a surety company, which promises to pay the client if the contractor fails to fulfill their end of the deal. So, for example, if acontractor falls in to administration, and you have paid in advance for the work, then you can file a claim with the Surety, and they'll make sure that you are paid for your damages.

How Much Does a Performance Bond Cost?

Performance bonds are issued by surety companies.

The surety company usually evaluates the contractor’s financial strength before deciding whether or not to issue the bond. They also check if any other claims were made against the contractor in the past.

The cost of the bond depends on many factors—the amount of the bond and credit score being two of them—but typically, bonds cost 1-10% of what they're guaranteeing.

If There's a Claim on My Performance Bond, Who Pays?

If there is a claim made against a performance bond, it will be investigated by the surety company. If they are convinced that their client has violated his contractual obligations, then compensation will be provided to the employer by the surety.

If you fail to complete your project as agreed in your contract and fail to remedy this failure when given reasonable time to do so, then your client can file a claim on your performance bond.

Keep in mind that performance bonds are fully indemnified. This means that in the event of a claim, the contractor will be required by law to pay back the surety company. The amount they’ll be paying back consists of the claim amount and additional expenses incurred by the surety company.

It's important to note that performance bonds are not insurance policies—if something goes wrong and you lose money on a project because of a contractor's negligence or carelessness, you may still be able to collect damages from their insurance policy. Performance bonds only cover financial losses if a contractor fails to complete the job or defaults on it and leaves it unfinished.

Conditional vs. On-Demand Bonds: What’s The Difference?

On-demand performance bonds are a type of performance bond that is paid to the employer on demand. This means that if the employer requests the money, they will receive it immediately regardless of whether the contractor was in breach of the contract.

Conditional bonds take effect only if certain conditions are not met. For example, if a company fails to meet the terms of its contract with the employer, the employer may require them to pay up in order to finish their work. The key difference here is that the employer will have to prove their loss to receive the amount of money stipulated under the bond.

Performance Bonds Benefits

Contractors can benefit from performance bonds in a number of ways, from providing them with more opportunities to bid on projects to limiting their liability. Here are some of the most significant benefits they receive:

1. Contractors can increase their chances of being awarded contracts with required performance bonds. In fact, many owners will only consider contractors who have provided performance bonds.
2. The performance bond will limit liability if the contractor fails to complete the job as laid out in the contract terms and conditions.
3. By itself, the performance bond is evidence of the contractor's financial stability. Companies that take out performance bonds have secured credit and assets that can be used to bail them out if needed. This means that contractors who can't meet these requirements may not be worth your time or money.
4. It protects you from contractor dishonesty. A dishonest contractor will do everything in their power to convince you of their honesty—even going so far as to make false claims about their financial status and history of successful projects. The performance bond will identify any dishonest contractors quickly by confirming whether or not their claims are true.
5. It reduces risks for everyone involved. Of course, performance bonds protect the project owner from loss, but they also give peace of mind to the general contractor and subcontractors by ensuring they'll be covered in the event that unforeseen circumstances make them unable to finish the work.

Why Use Surety Bonds & Guarantees?

At Surety Bonds & Guarantees, we're passionate about the surety industry in the  UK—what it is and what it can be. Our experts have decades of experience in the field and are constantly seeking to expand their knowledge through continuing education and training.

We're a team of professionals who are committed to providing our clients with the most comprehensive support they could ask for. On top of that, we offer competitive premiums, and have access to most providers and exclusive markets that other surety companies might not have.

Do you need a surety company? If so, you should give us a call. We'll help you every step of the way, from getting started on your application to submitting it and receiving your bond. We know it can be frustrating to try to figure out how to start the licensing process for a surety bond, so we'll do the legwork for you.

So what are you waiting for? Call us now at 02476 017646 to get expert advice from our team of specialist bond brokers.